Two Federal Reserve policymakers said that even though the unemployment rate will likely stay high for a while, the U.S. central bank needs to guard against the potential for inflation as it unwinds its extraordinary economic support.
Philadelphia Federal Reserve Bank President Charles Plosser said Tuesday he expects the unemployment rate will begin to decline by the end of 2010.
But such sluggishness in the labor market, he said, should not deter the U.S. central bank from raising rates.
Keeping interest rates too low, too long could potentially lead to a burst of inflation or sow the seeds of the next crisis.
Plosser repeated his view that the Fed should raise its target federal funds rate before unemployment — currently at 10 percent — has returned to "acceptable levels."
Richard Fisher, president of the Dallas Federal Reserve Bank, also gave a fairly grim assessment of the labor market, telling reporters after giving a speech to the Waco Business League in Waco, Texas, that the jobless rate will remain "quite high for some time".
Fisher said he doesn't see "pervasive inflationary pressures presently," but cautioned the Fed must pursue a strategy to unwind the extraordinary policies it has undertaken in the last year to support the economy that "won't lead to inflationary pressures."
Neither Fisher nor Plosser is a voter on the Fed's policy-setting panel this year.
The Fed cut the federal funds rate — the benchmark U.S. interest rate — to near zero percent in December 2008. It has also put in place a raft of emergency programs, including one to purchase $1.25 trillion worth of mortgage-backed securities, to help guide the U.S. economy out of the worst recession in some 70 years. The Fed's extraordinary actions more than doubled its balance sheet to around $2.2 trillion.
The Fed has pledged low rates for "an extended period" and most analysts do not expect the Fed to raise interest rates until the second half of 2010.
Plosser said expectations for future inflation are currently "well-anchored," but warned that there is "considerable uncertainty" clouding the outlook for price pressures over the next two to five years.
Plosser, known as an anti-inflation "hawk," told the Entrepreneurs Forum of Greater Philadelphia that officials need to be preemptive and consider what the inflation outlook will be and how the economy will look in 2011 and beyond.
"I believe the Fed will need to withdraw the extraordinary amount of liquidity it has provided to the economy and begin to raise interest rates as the economy continues to improve and financial markets return to more normal operation," he said.
"If it fails to do so, rising inflation expectations could prompt workers to demand higher wages and firms to demand higher prices to head off the expectation of higher costs, thus setting off a burst of inflation."
A few Fed officials have suggested continuing or expanding the Fed's mortgage-backed securities purchases beyond their scheduled completion at the end of March to nurture what has been a weak recovery and to prevent potential disruptions to the housing market.
Plosser, disagreed, saying the Fed should end the MBS purchase program by the end of March as planned.
"I believe it is important that we do so and reduce our participation in this market, so the private market can once again resume a significant role. It cannot do so as long as the Fed is the dominant player," he said.
If the Fed's purchases were to continue it would "risk delaying the return to normal market functioning," he said.
Fisher, when asked about the mortgage-backed securities program, said the Fed was nearing the end of the program and that the next step for the central bank "is to figure out how to unwind the expansion of our balance sheet."
Both Fisher and Plosser warned that fiscal deficits and attempts to politicize the Fed are roadblocks to economic recovery.
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